Truly a Beast

The PMI data released
Showed just how fast growth has decreased
Tis services that
Have fallen so flat
This virus is truly a beast

But yesterday two bits of news
May help prevent any more blues
The Fed started things
By spreading their wings
And buying all debt that accrues

As well, in a break from the past
The Germans decided at last
To open the taps
As well as, perhaps
Support debt Italians amassed

And finally, where it began
The virus, that is, in Wuhan
Two months from their dawn
Restrictions are gone
Defining the lockdown’s lifespan

Markets have a much better tone this morning as traders and investors react to two very important responses to the ongoing Covid-19 crisis. The first thing that is getting a positive, albeit delayed, response is the Fed’s enactment of a series of new programs including support for CP, mortgage-backed securities, primary dealers and money market funds as well as embarking on QE Infinity, buying $75 billion of Treasuries and $50 billion of mortgage-backed securities every day this week, and then on into the future. Previous concerns about the size of the Fed’s balance sheet relative to the US economy have been completely dismissed, and you can bet that we will soon see a Fed balance sheet with $10 trillion in assets, nearly 50% as large as the economy. But the announcement, while at first not getting quite the positive impact desired, seems to be filtering through into analysis and is definitely seen in a more positive light this morning than yesterday at this time.

The second piece of news was that not only is Germany going to embark on a €750 billion spending program to help the economy, but, more importantly, they are willing to support Italy via European wide programs like the European Stability Mechanism, and even jointly issued coronaviru bonds, to prevent a further catastrophe there. In truth, that seems to be a bigger deal than the Fed, as the long-term implications are much greater and point to a real chance that the European experiment of integration could eventually work. If they move down the path to jointly issue and support debt available to all members, that is a massive change, and likely a long term positive for the single currency. We have to see if they will actually go forward, but it is the most promising structural comment in Europe in years, perhaps even since the euro was formed.

However, we cannot forget that the current reality remains harsh, and were reminded of such by this morning’s Flash PMI data, which, unsurprisingly, fell to record lows throughout Europe and the UK. Services were hit much harder than Manufacturing with readings of 29.0 in France, 34.5 in Germany, 31.4 in the Eurozone and 35.7 in the UK. Japan also released their data, which was equally dismal at 32.7 for Services PMI there. And they added to the story by releasing Department Store Sales, which fell a healthy 12.2%. Of course, everyone knows that the data is going to be awful for the time being, and since we saw China’s PMI data last month, this was expected. Granted, analysts had penciled in slightly higher numbers, but let’s face it, everybody was simply guessing. Let’s put it this way, we are going to see horrific data for at least the next month, so it will have to be extraordinarily bad to really garner a negative market reaction. This is already built into the price structure. While the US has historically looked far more closely at ISM data, to be released next week, than PMI data, we do see the US numbers later this morning, with forecasts at 42.0 for Services and 43.5 for Manufacturing.

So the data is not the driver today, which has seen a more classic risk-on framework, rather I think it is not only the absorption of the Fed and German actions, but also, perhaps, the news from Wuhan that the restrictions on travel, imposed on January 23, are being lifted, nearly two months to the day after imposition. Arguably, that defines the maximum lockdown period, although yesterday President Trump hinted that the US period will be much shorter, with 14 or 15 days mooted. If that is the case, and I would place the start date as this week, we are looking at heading back to our offices come April 6. If the Fed is successful in preventing financial institution collapse, and Congress finally passes a stimulus bill to address the massive income dislocation that is ongoing, (which they will almost certainly do in the next two days), there is every chance that while Q2 GDP will be hit hard, the panic inducing numbers of -30% GDP growth (Morgan Stanley’s forecast) or -50% GDP growth (St Louis Fed President Bullard’s forecast), will be referred to as the height of the panic. We shall see.

But taking a look at markets this morning, we see the dollar under pressure across the board, with the Norwegian krone today’s champion, rallying 5.4% as a follow on to yesterday’s reversal and ultimate 1.2% gain. But the pound has bounced 2.0% this morning along with SEK and AUD is higher by 1.7%. It is entirely possible that what we are seeing is a relief in the funding markets as the Fed’s actions have made USD available more widely around the world and reduced some of that pressure.

EMG markets are seeing similar strength in their currencies, led by MXN (+2.6%) and HUF (+2.3%), but every currency in both blocs is higher vs. the greenback today. Equity markets are all green as well, with major rallies in Asia (Nikkei +7.1%, Hang Seng +4.5%, Shanghai +2.7%) and Europe (DAX +6.25%, CAC +5.25%, FTSE 100 +4.0%) with US equity futures limit up in all three indices. Bonds, meanwhile, have sold off slightly, with yields higher in both the US and Germany by 2bps. I think given the overall backdrop, bonds are unlikely to sell off sharply anytime soon, especially given the central bank promises to buy unlimited quantities of them.

And I would be remiss if I didn’t mention gold, which is up 2.5% today and 6.2% since Friday’s close as investors realize that all the money printing and fiscal stimulus is likely to lead to a much different view on inflation, namely that it is going to rise in the future.

Volatility remains the watchword as 5% daily moves in the equity market, even when they are up moves, remain extremely taxing on all trading activities. Market liquidity remains suspect in most markets, with bid-ask spreads still far wider than we’ve come to expect. Forward FX spreads of 5-10 pips for dates under 1 year are not uncommon in the majors, let alone in things like MXN or BRL. Keep that in mind as you prepare for your balance sheet rolling programs later this week.

Good luck and stay safe
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Insane Consequences

The last time the Year of the Rat
Was with us, the markets fell flat
In two thousand eight
The crisis was great
Let’s hope this year’s better than that

Alas as the New Year commences
The Chinese can’t offer pretenses
That virus is spreading
And fears are it’s heading
Worldwide, with insane consequences

Markets this morning are on alert as fears increase regarding a more rapid spread of the coronavirus first identified last week in China. Late yesterday afternoon, Wuhan, the epicenter of the virus’ outbreak was shut down by Chinese authorities. This means that all air and long distance train travel out of the city has been halted. The thing is Wuhan has 11 million residents, larger than NYC, and keeping tabs on all of them is impossible. Then just hours ago, two other cities with a combined population of 8.5 million, Huanggang and Ezhou, announced they, too, were restricting all long distance travel out as well as closing public spaces like movie theaters and internet cafes. The death toll attributed to this virus is up to 17 now, and more than 500 confirmed cases have been recorded.

The timing of all this is extraordinarily poor. China is about to embark on a week-long holiday celebration of the New Year, this year being the Year of the Rat. Typically, this is a time of active travel within and out of China, as well as a time of significant consumer activity. But clearly, locking down major cities with a population approaching 20 million is not instilling confidence anywhere. Chinese equity markets, which historically have always rallied in the last session prior to the New Year holiday, fell sharply last night, with Shanghai falling 2.75% and the Hang Seng down 1.5%. While this fear has not filtered into European equity markets, they remain essentially flat, we have seen increasing demand for Treasuries with the yield on the 10-year falling to 1.75% and German bund yields falling to -0.275%. The last piece of this puzzle is the yuan, which fell 0.4% in its last on-shore session ahead of the holiday. However, CNH continues to trade so do not be surprised to see further weakness there if we continue to hear more negative stories regarding the health situation in China.

But, back to the Year of the Rat. What does it mean in economic and financial terms? The Chinese have a twelve year cycle within their calendar, so the last Year of the Rat was in 2008. I’m sure you all remember how 2008 finished, with the financial crisis unfolding in the wake of Lehman Brothers’ bankruptcy that September. Clearly, nobody wants to see that happen again! But there are certainly anecdotal indicators that might give one pause. The latest anecdote comes from Bob Prince, CIO of Bridgewater Associates, the giant hedge fund, who explained that “…we’ve probably seen the end of the boom-bust cycle.” This is disturbingly similar to a different Prince, Chuck, the former CEO of Citibank, when he defended loosening lending standards in 2008 by remarking, “As long as the music is playing, you’ve got to get up and dance. We’re still dancing.” Perhaps an even more famous comment of this nature was made by Irving Fisher, the renowned economist whose work on debt-deflation and in monetary economics earned him wide acclaim, but who just nine days before the stock market crash of 1929 declared that stocks had “reached what looks like a permanently high plateau.” Now granted, 1929 was not the Year of the Rat, but pronouncements of this nature do have a habit of coming back to bite the speaker in the butt. Given the remarkably long tenure of the current economic and stock market gains, caution that things might change is in order. I’m not predicting an imminent collapse of anything, just highlighting that many market prices seem somewhat excessive and reliant upon a continued perfect outcome of moderate growth and easy money.

Looking at this morning’s activity, the major news will be made in Frankfurt, where the ECB has left policy unchanged (Deposit rate -0.5%, QE €20 billion/month) and now all eyes and ears will turn to Madame Lagarde’s press conference at 8:30 NY time. She is expected to announce the results of the ECB’s internal review of their inflation target, with the ongoing “close to but below 2.0%” likely to be changed to a more precise 2.0%, with an emphasis on the symmetry of that target, implying that slightly higher inflation will be acceptable as well. Alas for the ECB, higher inflation is just not in the cards, at least as long as they maintain interest rates at -0.5%. They can push on that string as much as they like and still will not achieve their goals. As to the single currency, this morning it is unchanged, continuing to hover just below 1.11, right in the middle of its effective 1.10/1.12 range that has been in place since October. We will need something really significant to change this mindset, and my sense is it will not come from within the Eurozone, but rather be driven by the US.

Other than that story, the UK Parliament approved the Brexit bill, which now needs to be ratified by the rest of the EU and is due to be addressed next Wednesday. Then Brexit will well and truly be done, a scant forty-two months after the initial vote. Of course, the next step is the trade negotiations, but even Boris would not risk blowing things up, now that he is in power, so look for an approved delay and an eventual deal next year. Meanwhile, the pound, which has been the best performing G10 currency this week, has stopped its run higher for now, and is actually lower by a modest 0.15% this morning. The other G10 currency movement of note was the Aussie dollar, rallying 0.4% after Unemployment surprisingly fell to 5.1%, thus offering some good news for a change.

In the emerging markets, while CNY is the biggest loser, the rest of the space has been pretty uneventful. On the positive side, CLP is higher by 0.5% after the central bank there indicated they would start to intervene if the peso started to decline too rapidly on the back of weakening commodity prices.

Aside from the ECB press conference, there are two pieces of data today; Initial Claims (exp 214K) and Leading Indicators (-0.2%). But at this point, unless Lagarde says something very surprising, it is shaping up as a very quiet session.

Good luck
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